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Contributed by Wayne Ferbert, co-founder of Alpha DNA Investment

The Hedged Equity investment space makes a very promising offer: the balance of Growth and Downside Protection in the same portfolio. It is a compelling promise and it has led to increased adoption in this space. But it is not a coincidence that the strategies in this space that are growing fastest are the ones with the highest Capture Ratio. And the strategies with the lowest Capture Ratios are losing investor interest.

Capture Ratio is calculated as the annualized returns of the Hedged Equity strategy divided by the annual returns of the index that the strategy is designed to track. Simply put, it is the amount of the returns of the underlying index that the manager has managed to capture after the impact of the tactical decisions around hedging and equity construction.

A Capture Ratio that is less or more than expected should lead to specific diligence questions of the investment manager. Every hedged equity strategy contains equity exposure, a hedge, and usually some tactical efforts to pay for the cost of the hedge. If the capture ratio is not as expected, the investor should ask which of these components caused the divergence in the Capture Ratio. The investor can then determine whether the manager’s decisions were consistent with the strategy’s promise.

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